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The Case for Emerging Europe

September 4, 2012

If history had turned out differently, the USSR would’ve taken home the most Olympic medals this year, as the total awarded to athletes from the area was 163, according to a blog on Foreign Policy’s website. As we all know, the Wall came down, the Soviet Union collapsed, and now Russia has to be content with its third-place position of 82 medals. Athletes from the United States were awarded the most medals (104), followed by participants from China, who took home 88.

In another contest, the U.S. stock market outperformed many developed and emerging equity markets for the year as of the end of August. Despite the negativity surrounding corporate earnings, lower economic growth and ongoing political uncertainty, the S&P 500 ETF rallied, climbing 13 percent through August 30.

By comparison, the iShares S&P Europe 350 ETF only rose 6.9 percent.

What seems to be overlooked by investors is the fact that stocks in Emerging Europe have also seen noteworthy results. As you can see in the chart below, the Eastern European Fund (EUROX) rose nearly 10 percent over the same time frame. Turkey was a significant contributor to those results, with stocks in the country climbing almost 40 percent; Russian stocks only advanced about 4 percent.

With the underperformance of the iShares S&P Europe 350 ETF, many investors have interpreted this as a contrarian sign to hunt for bargains in developed Europe. However, if you believe that Europe will see better days ahead, greater opportunity may lie to the east.

Here are three reasons to look at Emerging Europe stocks today:

1. Better GDP Growth Potential
The companies in the Eastern European area are located in countries set to grow faster than the U.S. and countries in Europe. Russia and Turkey are projected to have a GDP of about 4 percent this year, while Poland’s GDP growth is expected to be 2 to 3 percent.

2. Stocks are Undervalued
Along with benefiting from higher GDP growth, many of these stocks are historically undervalued. BCA Research looked at certain value metrics of several emerging market countries, including the trailing and forward price-to-earnings ratio and price-to-book ratios and compared these figures to the historical average going back to the early 1990s. Poland has a reading of about 1.2, which means that today’s price-to-earnings and price-to-book ratios are 1.2 standard deviations below the historical mean. Conversely, Mexico’s reading of -1.5 indicates that stocks in this country are historically overvalued.

Among emerging countries, Poland, Russia and Turkey are the better values, says BCA.

BCA also looked at the emerging markets where growth was expected to improve over the next five years compared to the previous two years. Among “the most favorably-placed markets” for valuation and economic growth were Russia and Poland.

3. Attractive Dividend Yields
Many Eastern European stocks pay attractive dividends, allowing investors to benefit from income and potential appreciation. As of June 30, 2012, the stocks in the EUROX portfolio had an average dividend yield of more than 5 percent.

Dividend income may not be the only benefit: According to research from ING Bank, there appears to be a healthy dividend effect on stock outperformance in emerging Europe.

The chart below shows the cumulative average outperformance 40 days before and 40 days after the ex-date among dividend-paying stocks in Europe, Middle East and Africa (EMEA) countries. The outperformance has historically started about 10 days before the ex-date and continues throughout the next 40 days. The ex-date is the day on or after which a security is traded without a previously declared dividend or distribution.

While this effect is seen throughout the EMEA countries, “Turkish stocks appear to be most attractive dividend effect plays with outperformance of 5 percent on average,” according to ING.

In today’s low yielding environment, dividends have been particularly attractive to investors. Martin Barnes, chief economist at BCA Research, writes to subscribers that he believes that in today’s uncertain environment, investors can still “build an equity portfolio of global companies with strong balance sheets, powerful brands and paying reliable and decent dividends. Not the most exciting investment strategy perhaps, but one that should pay off in the long-run.”

Price Reversal Indicates Attractive Entry Point?
As you can see below, over the past month, EUROX has moved above its 50-day moving average. This indicates to us that there is growing strength in the Eastern European area and an attractive entry point for investors.

The Eastern European Fund isn’t the only fund signaling a potential price reversal—all equity funds at U.S. Global Investors are above their 50-day moving average. Click here to see the charts.

Total Annualized Returns as of 6/30/12

1-Year

3-Year

5-Year

10-Year

Gross
Expense
Ratio

Eastern European Fund

-24.68%

7.09%

-10.06%

9.74%

1.98%

SPDR S&P 500 ETF

5.26%

16.23%

0.16%

5.23%

0.10%

iShares S&P Europe 350 ETF

-13.00%

-2.31%

-10.65%

-1.45%

0.60%

Expense ratios as stated in the most recent prospectus. Performance data quoted above is historical. Past performance is no guarantee of future results. Results reflect the reinvestment of dividends and other earnings. Current performance may be higher or lower than the performance data quoted. The principal value and investment return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance does not include the effect of any direct fees described in the fund’s prospectus (e.g., short-term trading fees of 2.00%) which, if applicable, would lower your total returns. Performance quoted for periods of one year or less is cumulative and not annualized. Obtain performance data current to the most recent month-end at www.usfunds.com or 1-800-US-FUNDS.

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

Dividend yields are as of 6/30/2012. These figures do not represent the funds’ yields, which may be materially different from the average yields of the stocks held in the funds.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio. The Eastern European Fund invests more than 25 percent of its investments in companies principally engaged in the oil & gas or banking industries. The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund’s performance more volatile.

Please consider carefully a fund's investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by clicking here or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

With respect to the Fidelity Institutional Money Market Treasury Portfolio, which is distributed by Fidelity Distributors Corporation, an investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

Read additional important information.

Bond funds are subject to interest-rate risk; their value declines as interest rates rise. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local income taxes, and if applicable, may subject certain investors to the Alternative Minimum Tax as well. The Near-Term Tax Free Fund may invest up to 20% of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes. The tax free funds may be exposed to risks related to a concentration of investments in a particular state or geographic area. These investments present risks resulting from changes in economic conditions of the region or issuer.

Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.

The Emerging Europe Fund invests more than 25% of its investments in companies principally engaged in the oil & gas or banking industries. The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund’s performance more volatile.

Because the Global Resources Fund concentrates its investments in a specific industry, the fund may be subject to greater risks and fluctuations than a portfolio representing a broader range of industries.

Stock markets can be volatile and share prices can fluctuate in response to sector-related and other risks as described in the fund prospectus.

Morningstar Ratings are based on risk-adjusted return. The Overall Morningstar Rating for a fund is derived from a weighted-average of the performance figures associated with its three-, five- and ten-year (if applicable) Morningstar Rating metrics. Past performance does not guarantee future results. For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating? based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.)

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